Taxation of leases that are not long funding leases: net present value and calculating rents: example of illustrating 'net present value'
Consider this very simplified example. Suppose that
- a finance lessor’s investment in plant today will save them tax of £1,000,000 in a year’s time
- the lessor will have to pay tax of £1,200,000 in five years’ time on the profit from leasing the asset.
With a 10% interest rate
- the net present value of the £1,000,000 saved next year is £909,091 (£909,091 invested today at 10% yields interest of £90,909 in a year’s time; so £909,091 invested now + £90,909 interest amounts to £1,000,000 in a year; or working back from the future sum of £1,000,000 x 100/110 = £909,091)
- the net present value of the £1,200,000 is £745,106 (compounding £745,106 at 10% for five years = £1,200,000; or working back from the future sum of £1,200,000: £1.2m x (100/110 x 100/110 x 100/110 x 100/110 x 100/110) = £745,106).
In short, the net present value (the ‘real’ value today) of the £1,000,000 saved earlyon by the finance lessor (£909,091) is greater than the net present value (the ‘real’value today) of the £1,200,000 due in five years (£745,106). So the deal looks profitable for the lessor.